Electronic Stock Certificates or Uncertificated Shares?

As a founder, many professional conversations you will have will be about equity and stock options for investors and employees. Shares of your startup are distributed as a form of compensation for employees. They are also an incentive for investors to invest in your company.

Shares used to be traded through physical stock certificates for shareholders to prove their stock ownership. With the rise of the internet and online trading, paper stock certificates have mostly become an element of the past.

For the most part, startups issue company shares electronically and no longer exist in paper form. Issuing shares can be done a number of ways digitally, avoiding the classic paperless stock certificates used in the trading days of the past. Understanding the basics of stock certificates can help you understand the best option for your startup. Read on to learn more about the digitization of shares and electronic stock certificates.

What is a Stock Certificate?

Stock certificates are a document that provides proof of ownership of shares of a company. They are the distribution of shares to founders, cofounders, employees, and investors. There are three types of stock certificates companies can use to distribute shares. They are paper stock certificates, electronic stock certificates, or uncertificated shares. Each one helps identify who has ownership in a startup and how many shares each person owns.

Paper Stock Certificate – A paper stock certificate is an intricately designed paper certificate that features a corporate seal and important signatures that helps prevent replication. The paper stock certificate represents share ownership in a company or a startup.

Electronic Stock Certificate – The electronic stock certificate is a digital version of the paper stock certificate. It is only available in document form, such as PDFs.

Uncertificated Shares – Most people receiving shares in a startup accept and even prefer uncertificated electronic shares. There is no need for a paper or electronic certificate to show ownership in a company as a shareholder.

Most companies have moved away from issuing paper stock certificates and opted for issuing uncertificated shares. Uncertificated shares are easier to manage and a more cost-effective option for distributing and managing ownership and shares.

Certificated Shares Vs. Uncertificated Shares

Shares for companies can exist in either certificated or uncertificated shares. Certificated shares are the stocks that are represented through paper stock certificates that prove shareholders have ownership of a company. Uncertificated shares are tracked and represented through a company's books or electronically on a spreadsheet.

While paper stock certificates that are certificated shares may seem like a more official representation of ownership in a startup, more companies use electronic stock certificates or uncertificated shares. Legally, uncertificated shares represent ownership in a company and are recognized across the globe.

What is Included in an Electronic Stock Certificate?

Electronic stock certificates are just as intricate as paper stock certificates. They are a unique way to show ownership in a company. Electronic Stock Certificates will include essential information that shows the shareholder important information such as:

Certificate Number – The certificate number for accounting and tracking purposes.
CUSIP Number – The CUSIP (Committee on Uniform Securities Identification Procedures) Number is an assigned number featuring alphanumeric characters assigned to stocks and convertible debts.
Number of Shares – The stock certificate will include the number of shares purchased to reflect the value of the stock.
Date of Issuance and Names – It will include the date the certificate is issued and the names of the buyer and seller. The buyer will be listed as the current owner of the stock certificate.
Signature – Signatures help confirm that the stock certificate was signed by an authorized company representative.
Company Seal – The company seal helps provide authenticity to the certificate.

Disadvantages of Stock Certificates

While most companies have transitioned to electronic shares, paper stock certificates can still be requested and may still be in circulation. There are a few drawbacks to using paper or electronic stock certificates, in case your startup considers tracking ownership through certificated shares. Some disadvantages include the following:

Can Be Stolen or Lost – Tracking paper documents of any kind can be challenging, and you have to ensure safekeeping to prevent them from being stolen or even lost.
Can Be Irreparably Damaged – Paper certificates are unsurprisingly delicate and can be easily ripped, burned, or damaged due to the elements. Any damage can render them unrecognizable and unable to trade the shares for compensation.
Difficult to Audit – With no way to track them, it can be hard to audit the stock certificates distributed among employees and investors.
Can Be Transferred Without Knowledge – Paper stock certificates can be sold off with your knowledge or your consent. They would not be able to be included in your personal records of who has ownership in your company.
Can Be Digitally Lost – If you choose to do electronic stock certificates, computer crashes or cybercrimes can destroy the record of ownership for shareholders.

What Are Uncertificated Shares, and Why Are They Better?

While electronic stock certificates can be beneficial, and some investors may request paper or electronic stock certificates, many investors will choose to accept uncertificated shares. When you decide to issue uncertificated shares, you don't need to deliver a physical record. You would keep a transaction record in a stock ledger or excel spreadsheet.

If you choose to distribute uncertificated shares, you will need to ensure shareholders have access to these ledgers and provide them with statements so they can monitor their positions when they wish. As your company grows and the list of shareholders grows with it, you'll need to rethink your tracking solutions with uncertificated shares.

There are a lot of benefits and emphasis today in distributing uncertificated shares beyond the easy tracking and management of the shares in your startup. Other benefits include:

Less Complicated – Uncertificated shares are a less complicated way of distributing shares. You don't need to create stock certificate forms, whether paper or electronic. You don't need to acquire signatures or provide proof of receipt. You can simply email the shareholder with the information and provide them access to the ledger.

More Control – With uncertificated shares, you have more control over the transfer and sales of shares within your startup. Shareholders cannot perform any transaction without your knowledge or approval. Shareholders would have to consult the company in a formal procedure and gain approval for record keeping.

Cost-Effective – Managing uncertificated shares is a more cost-effective solution in the long run. Paper and electronic stock certificates are more expensive to create and are a time-consuming process.

Tracking is Easier – You can use a simple excel spreadsheet to track ownership in your startup, or there is software available that can simplify it even further.

Transitioning to Uncertificated Shares

If you began your startup by issuing certificated shares and have decided to switch to uncertificated shares, you could manage the process fairly easily. Uncertificated shares and stock certificates can coexist peacefully. The transition can be lengthy, time-consuming, and expensive, although it can be beneficial for tracking if you can reissue shares as uncertificated shares in exchange for paper or electronic stock certificates.

Before you move to uncertificated shares, be sure to gain board approval and the necessary authorizations. You'll want to ensure that everything is documented for approval so that you can issue uncertificated shares.

Once you have approvals, you can update the company's articles of incorporation and by-laws with the new information. Ensure you have a good system in place to track everything digitally in the company's ledger and begin distributing uncertificated shares.

Conclusion

While paper and stock certificates can be a great way to show ownership in a company, they can be more of a hassle to manage and track. In the long run, it can cost you more money to distribute shares in this way. More companies are using uncertificated shares as it makes tracking much easier and significantly reduces the cost of managing and tracking. No matter the choice, consult with your legal team to understand and ensure you comply with laws and regulations.

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